Should I Invest My Tax Refund?

A tax refund is a return on any tax you have overpaid in the past tax year. You may receive it for a wide variety of reasons, ranging from payments from a previous employer to foreign income. According to the IRS, this year’s average tax refund so far is $2,323.

If you’ve suddenly received one, you may be asking yourself: should I invest my tax refund? In this article, I’ll tell you everything you need to know.

Also see: Best Investment Apps

Is investing your tax refund right for you?

When it comes to investing your tax refund, there are both positives and negatives involved that you should keep in mind before you make your decision.

Read on to discover the things you should think about before you decide to invest your tax refund.

Benefits of investing your tax refund

You could generate a return

Since the interest rates offered by savings accounts are currently quite low, investing is potentially a great way to grow your tax refund and generate returns.

There is a huge variety of investment types that offer varying degrees of risk too, so even if you are a new investor that has a low tolerance for risk, there are options out there for you.

If you are new to investing, contributing your tax refund to an investment account could be a great way to start investing. Meanwhile, even if you’re an experienced investor, a tax refund could help boost your portfolio.

You should keep in mind, however, that the value of your investments can go down as well as up. If you’re unsure how to invest your tax refund, you should contact a financial advisor or a certified financial planner.

It could help you achieve your short- and medium-term goals

Investing your tax refund could also be a great way to meet any short- or medium-term financial goals you may have.

This could be anything ranging from saving toward the holiday of your dreams to the down payment for a house. An unexpected windfall of money can be the perfect, if unexpected, way for you to meet any of these goals you may have.

Things to think about before you invest your tax refund

You might need it for bills or debts

First and foremost, if you are thinking of investing your tax refund, you should ideally ensure that you’ve paid off any outstanding bills and debts, such as credit card debt or other types of high-interest debt. The sooner you do this, the better.

A tax refund could be a good way to become debt-free and gain some financial security, as the sudden influx of “free money” could potentially help you get ahead of the curve and take the weight of bills and debts off your shoulders.

Make a debt payoff plan if you want to be sure whether or not you can afford to invest your tax refund.

You may want to prioritize your emergency fund first

If the past few years have taught us anything, it’s that unexpected expenses can pop up without any warning. That’s why you may want to contribute your tax refund to your emergency fund before you think about investing it.

In a perfect world, you should be aiming to have a cash amount set aside for anywhere between three- and nine months’ worth of essential expenses. This rainy-day fund could be a literal lifesaver in case of unexpected circumstances or natural disasters.

It is important that the money you set aside for emergencies should be saved in an easy-access savings account, so you can access it at any time; after all, you never know when a financial emergency will arise.

Some financial peace of mind goes a long way in keeping you free of stress, so creating a savings plan and contributing your tax refund toward your emergency savings may be a great way to start saving for any eventuality, such as unforeseen medical expenses or car repairs.

3 clever ways to use your tax refund

If you don’t have any outstanding bills or debts, and your emergency fund is full, you may want to think about investing your tax refund and potentially watching it grow.

Continue reading to discover three clever ways to invest your tax refund.

1. Investing it in the stock market may offer decent returns

If you like the idea of investing your tax refund in the stock market and potentially watching it grow, then there are various different assets for you to consider. This includes:

• Stocks and shares
• Growth stocks
• Bond funds
• Commodities, such as gold and oil.

There are different types of investing accounts, including standard brokerage accounts, retirement accounts, education accounts, and investment accounts for kids. All have their perks and uses, but for general purpose investing using a standard brokerage account is the best choice.

Different providers offer various benefits on these accounts, so make sure you read my guide on the best investment apps to find out more about what these providers can offer.

A general investment account is an investment account that has no limits on the maximum amount you can invest, which is often not the case with tax-incentivized saving accounts such as IRAs.

You also are free to invest the money in a wide range of diverse assets, meaning you’ll be able to invest your entire tax refund through your account.

But this flexibility does come at a cost and you should be aware of the fact that you will need to pay taxes on earnings made in a standard investment account.

There are two different types of Dividend Tax, depending on whether the dividends are qualified or nonqualified.

The current tax rate on dividends starts at just 10% and goes all the way up to 37%, though these rates will depend on your current tax bracket.

2. Investing using a Roth IRA

A Roth IRA may provide a more tax-efficient way to invest your tax refund.

Similar to a normal investment account, a Roth IRA lets you invest in a variety of different options.

The beauty of the Roth IRA lies in the tax incentives—you will be entirely protected from taxes on any earnings your account makes as only contributions are subject to tax.

The tax-efficient nature of the Roth IRA means that contributions, for the year 2023, are capped at $6,500.

So, if you’re lucky enough to have a tax refund that’s greater than this amount, you may need to spread it across accounts.

As well as a Roth IRA, there are other types of IRA to choose from. All these accounts have their own particular features and incentives that differentiate them from one another, some of which may be more suited to your particular needs and requirements as an investor than others.

3. Contributing it towards your 401(k) could give you some peace of mind for your future

You may not have given any thought to contributing money to a pension. In fact, if you are younger, this may be the last thing on your mind.

But, using your tax refund to build retirement funds in a pension can be a good way to start securing your financial future for when you retire.

Of course, you should only do this if you don’t need your money right now. That’s because, typically, you won’t be able to make withdrawals from your pension until the age of 59 ½, at least without being penalized.

A 401(k) is highly tax-efficient in two ways. Firstly, any money invested helps reduce your current tax burden as any payments made by you are made prior to being taxed and, as such, help reduce your taxable income level.

There are different types of investment vehicles within a 401(k) plan. These usually include a mix of the following vehicles:

• Money market funds
• Stable value accounts, including guaranteed investment contracts (GICs) or bank deposit accounts
• Bond mutual funds
• Stock mutual funds
• Your own company’s stock

This mix helps ensure a diversified portfolio, though obviously your risk appetite and financial goals will play a part in determining where you would like to focus your investments. That said, most financial consultants will strongly advise against investing more than 10% of your plan into your own company’s stock.